R.C. Lim, Attorney and Counselor at Law

What Rising Credit Card Rates Suggest Is Looming Around the Corner

Although there have been a few reports of falling credit card fees, lowered charge-off rates by credit card issuers, and reduced consumer bankruptcy filings in certain parts of the country,  credit card fees have actually been increasing of late despite the record low interest rates for mortgage borrowers.

Not only are card companies facing losses from the increased number of bankruptcy filings, the recent legislation aimed at capping fees has left the companies scrambling to make up for lost revenues.

Given today’s headline regarding 27% drop in the sales of US homes for July from last month following the expiration of the $8000 tax credit, a fifteen year low, and the difficult to avoid conclusion that housing prices are still a long way from their eventual bottom, the more pressing question in consumer bankruptcy is why there have been so few to file. The easy answer, suggested by a recent study that suggested that baby boomers have filed consumer bankruptcy in far greater numbers than their Generation X and Y counterparts, would that the younger generations have held off from filing, perhaps more than they should.

An unfortunate aspect of my practice is that I see many clients who have taken irrational steps in the management of their debt by not earlier on considering consumer bankruptcy. Apropos the opening point regarding steps that banks have taken to offset recent losses resulting from federal action this year to cap various fees, it should be clear that the banks have many cards up their sleeves yet to play. In that case, the banks have responded by increasing rates and adding new fees to certain transactions, like overseas purchases.

In the context of California mortgage law, many borrowers who have lost their homes, many are likely falsely secure of their circumstance by virtue of the fact that their lenders have not yet chosen to go after them. However, borrowers should be aware that many are not protected by the ordinary non-recourse nature of first deeds of trust. For instance, many who have refinanced their homes may find that later, when and if their economic health recovers, that they will owe money from any balance owing on an earlier foreclosure.

Derivatives, Bankruptcy, and Wall Street

Reading this op-ed in the WSJ today left me scratching my head.

Evidently, prior administrations — Dem and GOP — took the position that derivative contracts needed a special set of rules and considerations in bankruptcy. Their chief fear seems to be that not doing treating them as having special considerations might rattle derivatives markets. Strange!

Now President Obama does not want to sign any new financial reform legislation that does not include some regulation of the derivatives market. This is evidently so important that he has threatened to veto any legislation that does not include provisions accomplishing as much.

President Obama forever the seeker of compromise has now evidently found a cause that he believes in. And this time, he’s flat wrong! Presumably prior administrations were eager to go along with bad policy because they were worried that the derivatives market was sufficiently complex that there was much that they did not understand. Most people’s eyes glaze over when the Black-Scholes equation and all of that icky math enters the picture. Finally, President Obama shows a spine, but it’s on an issue where he gets it exactly wrong!

The missing fact that President Obama is ignoring is that the majority of the derivatives market is compromised of individualized contracts between two parties that are peculiar to the situation and so cannot regulated as if they were traded on an exchange. Moreover, he fails to recognize that trading risk in this fashion accomplishes a good. Namely, risk is spread throughout the system. The dispersion of risk throughout the economy, when it is not in the exceptional circumstance of placing the entire economic order at risk of collapse, is a public good and needs to be encouraged by the government and not discouraged.

Derrick Coleman, NBA Star, Files Chapter 7

Derrick Coleman, the former number one pick in the NBA draft, recently filed for Chapter 7 protection under the bankruptcy code. His case will be one of the few Chapter 7 asset cases, and among his assets he lists many fancy cars and other tchotchkes one would expect an NBA great to have collected over a career as an NBA great.

Coleman owed more than $4 million than his assets were worth. As a high profile case, Coleman hopefully did a more thorough job filling out his schedules than the former auto dealer Danny Hecker I wrote about a few days ago did. Having made some $89 million over his career, Coleman’s monetary troubles seem to have come from investing money in his struggling hometown of Detroit.

I suspect that Coleman could have done a little better had he visited an asset protection planning attorney. One thing that such attorney can do is advise you on how to segregate your assets and risk so that when one business fails it does not spill over to the rest of your assets or businesses. This is what parent corporations do when they create subsidiaries. The subsidiary can then fail without harming the parent. In Coleman’s case, it might have allowed him to close a business without having his creditors reach his personal assets.  In the context of corporations owning corporations, this can be quite expensive — separate and then consolidated taxes and books for auditing. In the context of smaller businesses, the series LLC offered in several states makes this considerably easier and cheaper to accomplish.

California Homestead Exemption Increases By $25,000

The California homestead exemption protects a fixed amount of the equity in a person’s home from that person’s creditors. The means that judgement creditors cannot foreclosure on a property unless the person’s equity exceeds the amount permitted by state law. Under current California law, the base exemption is $50,000. If a person or a person’s s spouse resides in the home as a homestead, the amount rises to $75,000. For those over 65 years of age, disabled, or over 55 years of age with limited income, the amount jumps to $150,000.

On January 1, 2010, California will increase these amounts across the board by $25,000. (CA Assembly Bill 1046.) A client of mine mentioned that California to me in a hazy way, and I foolishly assumed that he was accidentally referring to the currently higher limit of $150,000 for the aged.  While this news did not pass unnoticed on the blogosphere, newspaper citations on the change are scant. I guess the newspapers assume (quite rightly) that their readership does not need to be reminded in any way of how much equity they’ve lost in their houses.

Bankruptcy Fraud Prosecutions Are Down

Even though a 2003 internal audit by the FBI suggested that as many as 10% of bankruptcy petitions then included some form of fraud, prosecutions are at their lowest level since 1986 even though bankruptcy filings are reaching new historic highs. The FBI it seems has chosen to focus on “other white collar crime” instead. Interesting!

Source: www.boston.com

Senator Dodd Has a Great Idea

The latest Senate banking bill suggests that the Federal Reserve Bank be stripped of its regulatory powers and that those powers be consolidated in one banking regulator (not the Fed).

It’s amazing to me how few get the significance of this gesture. Listening to the news on banking regulation over the past several months has been irritating. Many suggestions in the wake of crisis have been to expand the regulatory authority of the Federal Reserve Bank. Almost all have failed to recognize that the Federal Reserve Bank already had the regulatory authority over the banks that could have prevented the crisis from happening. The issue is that they failed to exercise it.

The Federal Reserve Bank is a classic case of what public choice theorists refer to as regulatory capture. Ironically, regulatory capture is an argument that is typically harnessed against the expansion of regulatory power. The argument suggests a method by which regulatory agencies can be “captured” by the corporate interests that they are charged with regulating. Here the Federal Reserve Bank has been “captured” by the ideology of deregulation and laissez-faire banking. The now dated but still superb account of the political inner workings at the Federal Reserve Bank is William Greider’s Secrets at the Temple. The ironic part is that regulatory capture is typically used as an argument against regulatory authority.

Bad and Getting Worse

In the same week that Equifax is reporting that small business bankruptcies are up 44% for the year, CIT Group, the nation’s largest lender to small- and medium-sized businesses is making a round through Chapter 11 in a prepackaged bankruptcy.

As was reported here, the prepackaged nature of this filing should help to prevent disruptions to existing customers. However, what that article and other commenters have ignored is that prepackaged or not, these events make clear what all small business owners know: there is no fresh capital available, and there is unlikely to be any available any time soon.

Banks are cutting back on lending across the board. Most of this is unequivocally a good thing. As a nation, most of the financial institutions, and most individuals too, were overleveraged by a lot. But small business as a percentage of GDP runs at approximately 50%. And CIT Group was the largest originator of SBA loans in the country. As an example, some 60% of the US clothing industry relies on the CIT Group for financing. Clearly, the CIT Group is too big to fail. The problem is, it would seem that Treasure Secretary Geithner has decided that it’s easier to walk away from the $2.3 billion of TARP money already invested in the CIT Group than to tussle with Carl Icahn, one the largest and most senior bondholders. I can understand the desire to find private solutions to our banking problems from here on out, but this case is obviously different. CIT Group is not only too big to fail, it’s also too big to stop originating new loans for worthwhile ventures.

Two Kinds of Insolvency

There are two different types of insolvency.  There is cash flow insolvency and there is balance sheet insolvency.

Insolvency is usually defined as not being able to meet one’s debts as the obligations mature. If you have debts that are due and are unpaid, a company may find itself in Chapter 11, even though it has assets and even cash flow to pay the obligations.

An example of this has recently occurred with General Growth Properties (GGWPQ), one of the largest owners of malls in the United States. General Growth Properties had financed a lot of its debt with commercial mortgage backed securities (CMBS). When the CMBS market disintegrated, General Growth Properties was unable to roll forward its maturing debt into a new CMBS securities because the market simply did not exist for this to occur. Unlike most home mortgages, commerical mortgages often do not amortize or pay down over the life of the loan and so they need to be refinanced at their termination.

After filing for bankruptcy, investors did not analyze the balance sheet properly and sold off the company to below a dollar. Clearly, all were anticipating that the stock would be canceled in the bankruptcy process. However, as has been made fairl clearly from Ackerman’s presentation, it is unlikely that the stock will be canceled in this case.

This example is a good illustration of the many ways that the moving pieces can come together in bankruptcy. What all bankruptcies share is a liquidity crisis. This, however, does not necessarily also mean that the company’s debts exceed its assets, particularly when many of the assets are illiquid.

Cram Down Redux

Evidently, the defeat of the cram-down provision several months ago doesn’t mean that it’s actually dead.

To summarize the issue briefly, a cram-down occurs on filing for bankruptcy when an undersecured asset is split into two portions - one secured and one unsecured.  As an example, if a house was purchased for $600,000 several years ago with a first mortgage and still has a half a million owing on it, then a bankruptcy court could change the mortgage so that only $500,000 was treated as a secured debt, while the other $100,000 would be treated as unsecured debt, like credit cards. This matters because it means a bank could be paid back less than it is owed on a house, which might occasionally happen through foreclosure but does not happen in Chapter 13.

Many are surprised to learn that this is the general rule in bankruptcy proceedings and can be done with all other assets — cars, boats, helicopters. First mortgages are treated different for some reason. My cynical guess here is that it is largely to do with lobbyists. Mortgage companies usually argue that it is a necessary to keep borrowing rates low and that if such a rule were to be changed, then borrowing costs would rise for all future borrowers.

The issue that perhaps all of the legislators are thinking about but not actually discussing: what would such a rule change mean for our already weakened (crippled) banking system. Last week, bank failures reached a record high of 109 for the year. The FDIC is now closing in on insolvency itself and has raised its fees to banks. And now there is a new storm brewing over toxic drywall to eat at the banks’ limited reserves and assets. Perhaps if home prices have really bottomed out, it will seem less risky to Congress.

Gordon Ramsay’s An Ugly Cow

The newspapers of the world are awash in ink telling the tale of how celebrity chef Gordon Ramsay was nearly forced to file for bankruptcy protection. If you know anything of his meteoric rise, you know that he has established a global restaurant empire in short order.

Five years and twenty restaurants.

These were not smart, low-risk expansions through licensing deals, like other celebrity chefs have done. He has done it by leveraging both his successful franchises and his name. If you’ve seen him on tv you well know, his appetite is large and his maliciousness is even bigger.

Here it seems he’s gone to the WSJ and tabloid news, not only to garner some more free publicity, but also to indulge his schadenfreude. While the seeming intent was to put a human face on the great Gordon Ramsay. It strikes me - someone who deals with much more deserving people in real life difficulties - a great sin when he searches for our collective pity at the loss of a Ferrari or London mansion.

I only hope that people read the article carefully enough to observe that Mr. Ramsay has admitted that part of his plan to save money includes stiffing diners on expensive ingredients, which he presumably still has every intention of charging them for!